The Performance-Based Pricing Fallacy: Part 2
In Part 1 we demonstrated that the Law of Diminishing Marginal Returns dictates that revenue sharing/commission and CPA models do not create the positive incentives they are widely thought to create. In fact, they create disincentives to push the limits.
However, even if the math suggested otherwise, there are at least 3 other grievous problems with “performance-based” pricing models.
- Performance Metrics Aren’t Simple. In eCommerce, CPA rewards a $10 order the same as a $500 order, which doesn’t make sense. Revenue sharing rewards a $100 dollar sale — with only $10 in margin — more than a $50 sales with $25 in margin, which doesn’t make sense. Even a margin sharing arrangement has it’s problems in that: they track ‘demand’ orders, some of which will cancel; and more pressingly there are often other performance factors that should be included that typically aren’t. You might be more willing to pay for new customers than existing customers, or business customers rather than consumers, and lifetime value considerations are completely ignored by these incentive structures. This doesn’t just mean the vendor doesn’t have an incentive to do the right thing, it can mean they absolutely have an incentive to do the wrong thing.
- The Metrics Commonly Used Can Be Artificially Inflated. Even retailers with real time credit card authentication have seen instances of fraud, with commissioned affiliates placing orders on line then canceling later. It’s not hard to set up a network of folks to share in that profit. For lead generation, and other soft performance metrics, fraud is much simpler to perpetrate. Page views? Time on site? Downloads? Videos watched? Networks of ‘bots can fool any fraud detection effort. But even if we ignore the possibility of fraud, it’s easy to cook the books.”Fill out this free application and you’ll get…”; whether it’s promotional language, or placement and prominence on the site, it can be trivially easy to increase the number of leads generated without increasing the number of quality leads. This is the point, all leads are not created equal. A mortgage loan application from someone in Beverly Hills is likely more valuable that a similar application from someone in a less swanky neighborhood.
- Commissions Are Paid For The Wrong Performance. In paid search, paying commission to a vendor for someone searching for your company by name is the definition of insanity. Someone searching for you by name (or by your name + coupon) was not compelled to do so by the ad that showed up after they searched! Similarly, crediting re-targeting or display with every order placed following an impression gives commission to far more non-incremental orders than incremental ones. Imagine the “uber ad” that is shown to anyone who boots up a computer or phone one day: did that ad drive all your web business that day? Of course not.Finally and obviously, attribution is a big deal here. Comparison Shopping, Affiliates, and Display Re-Targeting are often priced as revenue sharing agreements, and our attribution modeling system consistently shows that 50% – 80% of the credit for these last touch attribution channels should go to other programs that are really driving the business.
To reiterate a comment I made on the Part 1 post: there are certainly fine management firms that work hard and do what is in their clients’ best interest under some sort of performance-based pricing model. My point is simply that they are not doing good work because of the incentive structures created but rather in spite of those negative incentives.
Agencies perform well or badly because of the quality of their staff, the quality of their tools, their experience, and their long-term vision for profitable growth. Their reputation, and the quality of their client references will tell you more about their work ethic than any pricing model.